Cash is now a viable investment option for the first time in many years, and its appeal will draw money from other asset classes leading to poor performance both in financial assets and the real economy, according to Greg Jensen, co-chief investment officer at global investment management firm Bridgewater Associates.
Facing this scenario, investors should re-think their portfolios beginning with a the risk neutral position of cash before considering whether to layer on passive investment – or beta – and possibly some active views for alpha, he said.
“The risk neutral position in cash is actually relatively attractive compared to beta,” Jensen said, speaking with Colin Tate, managing director of Conexus Financial, at Conexus Financial’s Fiduciary Investors Symposium in Singapore.
“Essentially there’s very low risk premiums priced into most asset classes,” he said. “That means the benefits of taking risk relative to cash are low relative to history.”
A range of headwinds will make markets less beneficial for assets in the years to come, Jensen said.
We are moving from a world of globalisation and integration to a world of conflict and fragmentation, he said. This world is less productive and more inflationary than the markets investors have come to know, with greater government intervention and populism, and the rising need for enormous investment in climate initiatives.
Central banks and fiscal policymakers that have been innovative and active will be constrained by high inflation and debt levels, he said.
After a “huge pulling up of cash flows” over the last decade, asset prices are now extremely high relative to cash flows generated by economies, Jensen said, noting the last time the gap was this large was in 1975.
“The last time assets were this high relative to cash flows, you ended up with assets being flat for five to seven years and inflation driving nominal GDP to catch up with those high asset valuations,” Jensen said.
NORMAL RELATIONSHIP BETWEEN CASH FLOWS
Nominal GDP could exceed returns on asset prices for a long period of time as markets return to a normal relationship between cash flows in the economy and financial assets, which would make the coming years a “very rough time for financial assets,” he said.
And with cash returns reaching “extreme levels” compared to 10-year yields, 30-year yields, corporate debt and earnings, cash is now a viable choice for the first time in many years, Jensen said.
“That’s a big deal because that’s going to gradually draw money from other assets into cash,” Jensen said, meaning assets are likely to do relatively poorly compared to cash.
Facing this situation, it will be important for investors to stress test for various scenarios. This could be recession, it could be central banks losing their nerve and allowing inflation to rise, or it could conversely be that monetary tightening works and markets end up with a “Goldilocks” environment.
Investors need to consider how to protect their portfolios against the possibility of long term inflation, as the threat of long term inflation is not reflected in long term asset prices, which means “there is still a large risk that asset prices will decline as a result of a recognition that inflation won’t just go back to target,” Jensen said.
They also need to consider geographic balance, with history showing countries that do well in one decade tend to do less well in the subsequent decade.
And they should seek out good diversified alpha by finding managers that have a low correlation to their portfolio.
“Most people aren’t doing enough to say: ‘What are my alpha sources, and are they negatively or zero correlated to my portfolio?’” Jensen said. “If so, crank those up.”